Why Tenant Quality is Vital for DST Investment Success
Carl E. Sera, CMT
June 26, 2023
How to Evaluate the Creditworthiness and Stability of Tenants in a DST Property.
This article discusses the impact of tenant quality on DST investments. It explores how the quality of tenants can affect the value and stability of a DST investment property.
Oftentimes, investors doing a 1031 exchange into a DST investment are fixated on the property they are purchasing. Where is their money going - maybe an apartment building in Dallas or a portfolio of dollar stores in the Midwest?
Investors frequently "kick the tires" by examining the location, occupancy, rental revenue, and tenant credit quality variables. One question that often falls to the bottom of the list is how the quality of DST tenants can impact the outcome of the DST investment.
In this article, we’ll go over how the choice of tenants can impact DST investments and how to evaluate the creditworthiness and stability of tenants in a DST property.
What is a Delaware Statutory Trust (DST)?
A Delaware Statutory Trust is a legal entity formed under Delaware law that allows investors to own undivided fractional ownership interests in professionally managed institutional quality real estate offerings around the United States. The interests can be owned by individuals or by certain entities. DSTs are offered and available only to accredited investors (opens in new tab) and entities.
What Are The Common DST Property Types
Nearly all commercial real estate property types are held as DST properties, including the four major property types—multifamily, office, industrial, and retail—and niche property types, like senior housing, medical office, and self-storage.
For example, one DST may own a portfolio of class A multifamily apartments, while another may own an industrial building like an Amazon Distribution Center or net lease real estate with corporate guaranteed retail tenants like Walgreens or Whole Foods.
Other types of DST 1031 properties available to investors have included shopping centers, government-leased buildings, self-storage facilities, senior living communities, warehouses, distribution facilities, medical office buildings, fast food buildings, pharmacies, and grocery stores. Although DSTs can own multiple properties, they typically focus on a single property type. To diversify across different property types, an investor can invest in various DSTs.
The Impact Of Tenant Quality On DST Investments
It’s important to understand that the DST trustee can’t renegotiate loan terms taken out by the entity. The only exception to this is if a tenant has defaulted on its lease or has filed for bankruptcy. Along those lines, your sponsor might have to restructure a lease in the event of tenant default or bankruptcy unless a master lease is in place to handle this issue. This is the only time a sponsor can renegotiate a lease with a tenant. Under other circumstances, the sponsor can’t be involved with any lease negotiations with the tenants.
This is one of the many reasons why it is common for most DST sponsors to only work with an institutional-grade tenant such as FedEx, Walgreens, and other established businesses. For example, having established companies like Fedex as DST tenants have brought about excellent results over time due to its established nature, expense inflation protection protocol, and high-margin business model. While no one has a crystal ball and can predict the performance of any real estate asset or tenant, it is important to analyze the potential of DST tenants and their business models before investing in a DST.
When investors evaluate potential opportunities for their 1031 Exchanges, they should consider Delaware Statutory Trust offerings and those DST offerings that feature one major distribution and logistics tenant.
If you'd like to learn more about whether DSTs are a suitable replacement property option based on your individual objectives, please feel free to contact us at Sera Capital for a complimentary 30-minute consultation.